(PhysOrg.com) -- In the United States, ultrafast trading in financial markets between 2006 and 2011 was the underlying factor for over 18,000 extreme price changes, according to a new study. Neil Johnson, a professor in the physics department of the University of Miami in Coral Gables, one of the authors of the study, thinks that a buildup of such "fractures" can destabilize the market. This study, Financial Black Swans Driven by Ultrafast Machine Ecology was submitted to arXiv earlier this month, suggesting the link between extreme-change fractures and market crashes.

The authors looked at a set of what they call "18,520 ultrafast black swan events" that they uncovered in stock-price movements between 2006 and 2011. A case in point is what occurred on May 6, 2010, when it took just minutes for a spontaneous mix of interactions in cyberspace to generate the Flash Crash, first a plunge, in minutes, and soon after a recovery.

The speed in which the rises and falls occur might last no longer than half a second, unapparent to any human who is tracking prices. Johnson says if you blink you miss it. Flash events may happen in milliseconds and have nothing to do with a companys real value.

To examine such incidences and their frequency the authors of the study waded through price logs from over 60 markets collected by Nanex, a Chicago company that sells streaming market data. The data revealed that the ultrafast fracture events were not infrequent but common, totaling 18,520 in the 2006 to 2010 time span. The authors looked for extreme changes in a stock price, which they defined as a change greater than 0.8 per cent, over timescales shorter than 1.5 seconds.

The speed in which ultrafast events happen is of concern as human oversight becomes impossible if trades are taking place faster than humans can react. Machine trading today carries computerized trading algorithms that make automated trades in milliseconds and make some experts uncomfortable, in the fear that out-of-control algorithms can cause a crash.

Following the May 2010 event, U.S. regulators, as a safety mechanism, upheld circuit breakers designed to stop trading if a stock price makes a sudden large move. Whether or not that is the best solution around, considering the speed in which todays machine trading can occur, does not convince all market experts. At that level of resolution, one of the study authors said it was troublesome to even observe, leave alone regulate.

The authors suggest an early warning system for when the markets are becoming unstable. According to a Wired report, the authors would like to see an approach that might help steer automated markets by introducing rogue algorithms when herd behaviors appear imminent.

In a recent Q&A interview, Johnson said the fracture analogy to real materials is useful in assessing todays financial markets. Where we want to head to is the analogy of a trained aircraft engineer, who can pretty much look at the microscopic arrangement of small fractures in an aircraft and judge whether it is safe to continue flying that plane or not. To have this for markets would be an incredibly important step toward understanding, and managing, risk."

AbstractSociety's drive toward ever faster socio-technical systems, means that there is an urgent need to understand the threat from 'black swan' extreme events that might emerge. On 6 May 2010, it took just five minutes for a spontaneous mix of human and machine interactions in the global trading cyberspace to generate an unprecedented system-wide Flash Crash. However, little is known about what lies ahead in the crucial sub-second regime where humans become unable to respond or intervene sufficiently quickly. Here we analyze a set of 18,520 ultrafast black swan events that we have uncovered in stock-price movements between 2006 and 2011. We provide empirical evidence for, and an accompanying theory of, an abrupt system-wide transition from a mixed human-machine phase to a new all-machine phase characterized by frequent black swan events with ultrafast durations (<650ms for crashes, <950ms for spikes). Our theory quantifies the systemic fluctuations in these two distinct phases in terms of the diversity of the system's internal ecology and the amount of global information being processed. Our finding that the ten most susceptible entities are major international banks, hints at a hidden relationship between these ultrafast 'fractures' and the slow 'breaking' of the global financial system post-2006. More generally, our work provides tools to help predict and mitigate the systemic risk developing in any complex socio-technical system that attempts to operate at, or beyond, the limits of human response times.

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User comments : 28

Money does not and can ultimately never equal the production of goods and services which benefits society. Although money is a claim upon these benefits. The proper role of money is to facilitate increasing the productive power of society to sustain itself at ever higher standards of living. When this function is subverted crises result, such as the one we are currently experiencing. What is described here has nothing to do with bettering humanity, precisely the opposite. These types of detrimental gambling games should be abolished just as were the "bucket shops" of yesteryear. Anyone who would argue otherwise is either a fool or charlatan.

I agree with the above comment and would add that the purpose of investment is to provide capital investment for those who are taking risks in the marketplace.

Holding onto stocks for milliseconds does not constitute investment. It is a form of usury and money laundering.

The stock market should be regulated so that these kinds of fast trades are illegal. In fact if market stability is the goal then it should be a requirement that stocks be held for a period of months before they can be sold. In addition all manner of stock holders insurance needs to be outlawed as well as it would simply become a market for the illicit sale of stocks.

It basically follows from theory of PID regulators, because the machine trading represents the positive feedback sensitive to derivation of signal (stock prizes): the more they're volatile, the more they're subject of trading. Such regulators are naturally unstable.

The interests of society is not served by short term holdings.

It's the interest of monetary economy, which is atemporal by its very definition and it does care just about actual prices, so it becomes unstable by its very nature.

There are those whose sole purpose in life is to monitor every second of the stock market prices in order to protect their own or the investments of others. These people are usually retired or employed as advisors with many clients and have a great understanding of what's at stake if they don't do it right. The retired people are usually only in it for extra money to pay their bills, but those with clients must make money for those clients or they will lose the fees that they charge clients for this service.With automation & other technology comes responsibilities that are not always put in practice. It's not supposed to benefit ALL people, just the ones who invest in companies. A company that is failing, like Solyndra, deserved for its investors to pull out instantly, even though government invested heavily in it with taxpayer money. The remaining investors, if they saw that the company was failing, would have been fools to not sell immediately. Waiting is financial suicide.

Long term investments in ineffable equities went out with the last century. Now if you get information that gives you a trading edge, you need to act on it before the mom&pops get in on the action while watching the evening news. Holding onto a dying equity is suicide.

When will we see the results of a study that tracks these crashes, determines which entities profited from them and IF they or "someone they know' was involved in trading patterns that caused these events.

These events are governed by cause and effect...

Machine trading is both the biggest factor in these markets and the only method that can catch these events for the short and long.

How exactly could these events be "common" as the article states and not be making the front page of the wall st journal etc, reported as a threat to the market, if they aren't manipulated occurrences being carried out by multimillion and billion dollar entities?

pardon my tinfoil hat but, we won't be hearing anything of substance any time sooner than we hear about pre-911 short sales.

Holding onto stocks for milliseconds does not constitute investment. It is a form of usury and money laundering.

Even milliseconds can be crucial if an investor wishes to prevent losing his own money and/or any gains from that investment. It's a matter of who sells first and at what price the shares are sold. The last few to sell may be plain out of luck. Investing is a big gamble & there are very few who are unconcerned about losing their own money.

The stock market should be regulated so that these kinds of fast trades are illegal. In fact if market stability is the goal then it should be a requirement that stocks be held for a period of months before they can be sold.

That is utter nonsense. Only a fool would think that a goal to somehow stabilize the stock market is paramount to preventing a mad rush to sell shares if a company is highly volatile.

The super fast trade is a catastrophe built on top of a disaster, which was the already existing system of programmed revaluing of stocks. Grifters buy huge amounts of stock, automated systems dutifully recalculate the value of the stock based on programmed rules for how desirable the rarer availabel stock will be, then the con drops their huge pile of stock back into the system and scoop up the money, leaving the "pigeons" with worthless paper. More follows this.

"Flash trading" defeats the very meaning of revalued stock, and, for that matter, the meaning of "investment". Initially, investment, purchasing stock, was supposed to provide seed money for a corporation to undertake improvment or exapnsion, any of a number of moves to make themselves more profitable. And that succeeds. They do make more money and, suddenly, become more desirable. Of course, those who helped make the corporation better by putting money into it by buying stock, have that stock now in their possession, which means there is less for newly interested buyers. The corporation now is more valuable and needs more to improve beyond where they are and that adds to whatever "supply and demand" value there may be in their stock. But that is revaluation based on actual worth being put out by a corporation. More follows this.

Interests of Society?? ROFLOL.....Are you saying that, i.e., if I invest MY $20,000 in a stock that I have complete confidence in, whether or not the company makes money for me, the gains that my investment earns belongs to society and not just ME?? I suggest you go to a shrink and have your head examined.

"Flash trading" to artificially inflate the price of a stock, then depending on guaranteed buyers, like institutions and funds, to purchase the stock, circumvents that. A complete transaction on an oil corporation can be completed between one barrel being filled and a second. No worth generated but money taken. No wonder the planet is poorer than it was fifty years ago. Legitimate stock trades would require waiting until a suitable amount of time, usually in months, for stock to be redeemed. But the concept of "flash transactions" overall must be called into question. Transactions that take faster than humans react can completely undermine the idea of complete transparency as to one's own account. More follows this.

Banks utilize this commonly. Deposits can take up to three days to be honored, but withdrawals are honored instantaneously. Too many don't realize this. They put money into their checking, and think it's available to covcer an overdraft. But it isn't. And, even if you have overdraft protection, you still pay, $35.00 for each instance. But, the law reqires that a bank return a bounced check and the company resubmit it three times before an official overdraft. This used to take a few weeks, during which time, the individual could cover the problem. Now, the triple resubmitting takes place in less than a second, so people were charge more than $100.00 for a single overdraft. And many blamed themselves for being too free with spending. More follows this.

WIth financial transactions being conducted faster than many even follow, it can be like the vairation on the old comedy skit. Ten debtors surround a creditor in a circle. The creditor, with their bookkeeper, goes from debtor to debtor. The first hands over $10, the creditor gives it to their bookkeeper, the bookeeper hands it, behind their back, to the next debtor. Then the next debtor goes through the same process, then the next, then the next. In the end, all are tallied as having paid, but only $10 exchanged hands. Currently, counting the idea of expected profits, there could easily be twice as much "money" powering operations than there is in corporate manufactured value coming out. Corporations can operate at top speed and yet society can still be deep in debt! Incidentally, in business in general, unlike the skit, it's the little guy, not the creditor, who ends up shafted.

How much money has Bush made by trading stocks and not filing insider reports?

Corruption runs very deep. Much deeper anyone realizes.

You can ask that question of any American politician, Democrat or Republican, whether in the House or Senate. Ask Nancy Pelosi how she and her husband got their fortune. Also, how is it that Obama appoints tax cheats like Geithner as Sec. of the Treasury? And while you're at it, ask why Attorney General Eric Holder is not forthcoming with the truth about "Fast and Furious". SOMEONE has to go to jail!! There are far more serious corruption issues to consider and resolve in American politics that will bring American "society" down than whether or not I buy shares with MY $20,000.US and then sell those shares a minute later because I discover suddenly that someone in that company is a jerk who made the wrong move and my money is in dire jeopardy if I don't do something quick. I am nobody's fool, thank you.

I am of the opinion that trading companies are ordering trades over very short time frames, which inflates the impact of black swan events. If, over a period of milliseconds, you can hold back trades that don't benefit you and push forward those that do, you can skew the market. Black swans should be investigated, because they look like fraud is occurring.

I'm very tempted to create an algorithm that detects the beginnings of a flash-crash and exploits it for financial profit. Buy the stock when it's ultra low, then sell it for a massive profit seconds later. 18,000 events in 5 years is approximately 10 a day. Even if you could detect two a day you'd be making money. Do I think that's fair? Hell no. Would it work (given you have the bandwidth and computing power)? Probably.

Well, in the case of ABK, here's what happened: On the next day (11/10/09) ABK warned it may file for bankruptcy.NEW YORK -- Shares of Ambac plunged 33% Tuesday after the embattled bond insurer said it may be forced to file for bankruptcy protection. In a filing with the SEC late Monday, the company said it believes it has sufficient liquidity to get through the second quarter of 2011, but warned it could run out of money sooner.

So someone knew something, or feared the bankruptcy risk, or couldn't stomach the volatility, and sold regardless of the price offered.

Ultra Fast trading is the effect, not the cause..Real Cause is " weak hands " lack of commitment of money to long term investing...When I started on the Exchange, the NYSE traded 4 to 7 million shares a day...today up to two Billion shares a day... Machine trading ( electronic trading ) makes markets better..And as , humans , " Meaning the Old NYSE Specialist System, was more of a Fraud, true Warlords..

...Your point is Relative From a view that I will ANALOGIZE....

( Where there is smoke there is fire" ) Your viewing of the market is as a hiker seeing smoke from along distance..say from a side of a mountain .. looking with the human eye a 1/2 mile away in the distance ..You can see smoke and a glow... But there is more data of the market place ..Your missing many variables..

1)Is it a controlled fire, and ...How many people are tending it,sitting around viewing it .. ..And so on....

Ultra Fast trading is the effect, not the cause..Real Cause is " weak hands " lack of commitment of money to long term investing...When I started on the Exchange, the NYSE traded 4 to 7 million shares a day...today up to two Billion shares a day... Machine trading ( electronic trading ) makes markets better..And as , humans , " Meaning the Old NYSE Specialist System, was more of a Fraud, true Warlords..

...Your point is Relative From a view that I will ANALOGIZE....

( Where there is smoke there is fire" ) Your viewing of the market is as a hiker seeing smoke from along distance..say from a side of a mountain .. looking with the human eye a 1/2 mile away in the distance ..You can see smoke and a glow... But there is more data of the market place ..Your missing many variables..

1)Is it a controlled fire, and ...How many people are tending it,sitting around viewing it .. ..And so on....

The real issue is liquidity. Can someone at any time load or unload shares to continue with their financial plans? In the case of quote-stuffing, the answer is no. The crash of '87 happened because there was an utter lack of buyers. All the quotes were posted and yanked, meaning nobody was able to buy.

As I stated earlier, the purpose of the stock market is to provide companies with money needed for formation or expansion. Outside of that stocks have no socially acceptable purpose.

The formation and expansion of a company takes longer than nanoseconds, so the only purpose nano-second trading has is as a means of extracting money from those who do not have the same capacity.

Of course, those who do not have nano-second trading capacity are the average investors.

If the pubic interest is investment then the public interest is holding for longer than nano-seconds since this is not investment.

If the public interest is market stability then the public interest is in markets where investment - holding stocks for reasonably long periods of time - is the rule.

Establishing laws that require the holding of stocks from the time of purchase for periods on the order of months will decrease market volatility and produce a market that better serves the needs of society. Investment.

I agree with the above comment and would add that the purpose of investment is to provide capital investment for those who are taking risks in the marketplace.

Holding onto stocks for milliseconds does not constitute investment. It is a form of usury and money laundering.

The stock market should be regulated so that these kinds of fast trades are illegal. In fact if market stability is the goal then it should be a requirement that stocks be held for a period of months before they can be sold. In addition all manner of stock holders insurance needs to be outlawed as well as it would simply become a market for the illicit sale of stocks.

The interests of society is not served by short term holdings.

Simply requiring that stocks be held for an hour or a day would eliminate most of these types of manipulation. Another idea would be to force a lag time of a few seconds with a randomly added interval for stock price reports.

An even better strategy would be a very small (.005% - .015%) tax on stock transactions. Flash trading relies on the fact that in today's world, there are no actual costs in trading when your a board member of a trading house, and non-members have to pay a transaction fee to the trading house to trade stocks.

This will reduce liquidity some, so the actual tax rate would have to be adjusted so it would have minimal negative effects, but the positive effect would be less volatility.

Yes a random time lag would also suffice. Although an hour or a day would be too long in my opinion. A day would still allow markets to crash over a period of several weeks. Delaying crashes over months to years would be better as the delay would be long enough for people to change their sentiment, and value of course is based on nothing but perception.

Simply requiring that stocks be held for an hour or a day would eliminate most of these types of manipulation. Another idea would be to force a lag time of a few seconds with a randomly added interval for stock price reports.

These rules are already in place for those who don't meet the minimum capital requirements for trading. Imposing that on traders would eliminate intraday trading, which would harm market liquidity. That in turn causes crashes like the '87 US crash.

I see two problems. First Goldman Sachs has execution orders for much of the market, and they did not lose a single day in 2010 as a result of that inside information. Second, flash crowds drive down a smaller cap stock, panicking others to sell, then buy at that low,low price. This happens because of limited liquidity of the market and of small cap stocks in particular. I personally know of people doing this.